Friday, March 14, 2014

Consumer Reports on extended warranties

When you buy a new car, the dealer will try to sell you an extended warranty.  It would add on to your regular warranty, extending coverage for a certain number of extra miles or months.  It's like extra "repair insurance" for your car.

Is it worth buying?  I've always wondered, so when I saw that Consumer Reports (CR) tackles the subject in this month's magazine, I thought it might help with my decision next car.  

It turns out that CR believes an extended warranty to be a bad purchase.  Alas, their logic is so flawed that I don't think their conclusion is supported at all.

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Several months ago, CR surveyed 12,000 subscribers who had purchased an extended warranty for a 2006 to 2010 car, and asked them how satisfied they were.

But their answers don't tell us much, because of hindsight bias.  For instance, many customers were unsatisfied with their warranty *because their cars never broke down.*  


"100,000 miles came and went, and the car never needed any repairs other than regular maintenance.  What a waste!  I will never buy another extended warranty for a car," said Honda Civic owner Liz Garibaldi.

At the risk of stating the obvious: the fact that you didn't have a claim doesn't mean you shouldn't have bought the insurance.  In fact, you almost *always* hope not to use your coverage.  Your life insurance policy wasn't a waste of money just because you didn't die last year.  

You'd think CR would recognize the effects of hindsight bias.  They do, but concentrate only on the side of that supports their position:  


"[Making more claims] probably helps customers feel more justified about having spent money for the coverage -- a bittersweet way to rationalize the purchase."

But doesn't it go both ways?  What about customers who had the opposite experience, like Liz Garibaldi?  Why doesn't CR say,


"[Not having had a claim] probably helps customers feel unjustified about having spent money for the coverage -- a convenient way to rationalize not making the purchase in future."

"Rationalize" is a biased word, one that presupposes faulty reasoning.  CR doesn't use the second quote because they don't believe you "rationalize" a correct decision.  If the article were about fire insurance, instead, you can be sure it would be the second quote that would have made it into print.

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Buyer satisfaction isn't very useful in figuring out whether or not to buy an extended warranty, but what *would* be useful is to know what the coverage is actually worth.  On average, how much does an extended warranty save you, out of pocket?

In CR's survey, the median price of a warranty was $1,214.  The expected value of covered repairs would certainly be less than that, to allow for a sufficient margin of profit.  But how much less?  If it's only a bit less -- say, $100 -- it might be a small price to pay for peace of mind.  But if it's $1,000 less, then it's probably not worth it, even to the most risk-averse buyer.

So that's the key number, isn't it?  But CR doesn't give it to us.  They don't even try to estimate it, or acknowledge that it matters.  What they *do* tell us is:

-- 55 percent of owners didn't use their extended warranty at all;

-- of the other 45 percent, the median out-of-pocket savings was $837.

That helps a little, but not enough.  

First, why do they tell us the median but not the mean?  The mean is almost certainly higher than the median: a blown engine runs several thousand dollars.

Second, the survey includes warranties that are still in force, which means the final number will wind up higher once all the claims are in.  Wouldn't it have been better to restrict the sample to warranties that had already expired? 

From what we're given, all we can tell is that the value of the warranty is at least $376 (45 percent of $837).  But it's probably significantly more.  

It's very strange, the way CR laid it all out.  I don't know what was going on in their heads, but ... the most obvious possibility is that once they concluded that extended warranties were a bad buy, they chose to give only the numbers, arguments, and shadings that support their conclusion.   

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In a box, on the first page of the article, in a huge font, is the number "26%".  That's the "percentage of consumers who would definitely buy the same extended warranty again."

Note the word "definitely."  I've seen that word in surveys before ... usually, it's when they give you several choices: "definitely," "probably," "not sure," "probably not," and "definitely not."

But CR doesn't tell us the options, or even how many there were.  So how can we intepret what the "26 percent" means?  If the other 74 percent said "probably," that's very different from if they said "definitely not."  

The "26%" on its own doesn't mean anything, but if you don't realize that -- or you miss the word "definitely" -- it sure looks damning.

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On the second page of the article, there's a box with a picture of an unhappy looking customer named Helene Heller, who says,
"It was a horrific experience.  I feel like the dealer ripped me off."

Ms. Heller makes no other appearance in the article.  We never find out why the experience was horrific and why Ms. Heller feels cheated.  It sounds like what someone would say when the dealer refuses to honor a claim.  Perhaps there was a dispute over whether a particular problem was covered?  

Probably not, since the article doesn't actually raise any issues about claims being dishonored -- or, indeed, any issues other than cost and usage.  So, we're in the dark.

Expecting us to judge by anecdote is bad enough, but CR refuses to even give us the anecdote!

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Another photo features Brent Lammers, who says,
"I feel like I probably paid too much for peace of mind."

That's a fair enough comment, but ... why choose that one?  Since 26 percent of buyers would "definitely" repeat their purchase, CR could have easily find a quote from someone who feels otherwise.  And was there nobody who blew a transmission and regretted *not* buying the warranty?

In any case, what's the relevance?  We don't want to know what Mr. Lammers feels.  We do want to know if he did, in fact, pay too much.  We never find out.

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And then there's the title: "Extended warranties: An expensive gamble."

That's completely backwards!  The warranty may be expensive, but it isn't a gamble at all.  The gamble is in NOT buying the warranty!

A gamble is something that increases your risk.  That is: it increases the variance of possible outcomes.  You can have a sure $10 in your wallet (variance of zero), or you can bet it on a hand of blackjack (outcome from $0 to $25).  

If you buy the warranty, you're buying certainty: $1,214, or whatever, is what your repairs will cost.  If you don't, anything can happen: you could be out anywhere from zero to tens of thousands of dollars.  That's why the warranty gives some people "peace of mind" -- it eliminates the worry of the outlier, an extremely expensive repair bill.

Now, it's fine to accept the gamble if the warranty is too expensive.  There's only so much a reasonable person should be willing to pay to eliminate the risk.  But a justifiable gamble is still a gamble.

What CR was probably thinking, is something like this: "buying the warranty is a bad decision, and you could easily regret it if the car doesn't break.  That sounds like a gamble to us."  

But: a gamble is a gamble regardless of whether or not it's a good decision. If the manufacturers had a 60% off sale on an extended warranty, I bet CR would quickly stop calling it a gamble.  But a gamble doesn't stop being a gamble just because the odds shift in you favor.

Moreover, *any* decision can lead to regret over the alternative.  If a tipster suggests I put a month's pay on a certain longshot horse, I'll probably pass.  I will certainly regret that if the horse winds up winning at 100:1.  But my regret doesn't mean my refusal itself was a "gamble."  

There's some "status quo bias" here too.  Suppose that, historically, the extended warranty was built into the price of the car, but you could get $1,214 back in the mail by agreeing to get rid of it.  CR's headline would now have to read: "Keeping your six-year warranty instead of forfeiting half of it: an expensive gamble."

Less likely, I'd say.

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There's one thing that CR didn't talk about that I wish it had.  When I got my car, I wondered if the warranty might pay for itself when I eventually sold the vehicle. 

Suppose that my $1,500 warranty has an actuarial value of only $1,000.  Wouldn't I recoup the extra $500 when I sell the car?  If I'm still covered, buyers will be able to expect that there are no significant problems with my car (because I'd have had them fixed for free).  And, since most warranties are transferable, they can even claim any repairs that I missed.

I know I'd pay a lot more than a $500 premium for a car still under warranty, and I bet others would too.

CR didn't consider that.  Still, if they had at least told us the actual value of the warranty, I might have been able to estimate it for myself.

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OK, here's the final kicker.  After ragging on warranties with every argument they can think of for why they're not worth the money and you'll regret having bought one ... CR actually recommends you buy one!


"Consider an extended warranty for the long haul.  All cars tend to become less reliable over time, so an extended warranty might be worth considering if you're planning to keep your vehicle long after the factory warranty runs out."

What they seem to be saying is: we just spent hundreds and hundreds of words telling you, over and over, why extended warranties aren't worth it.  But we meant that only for short warranties.  For long warranties, you should buy one, because our reasoning doesn't apply any more!

Why the change of mind?  

It's true, of course, that cars break down more often when they're older.  But the prices of the warranties rise to reflect that.  Don't they?  Does CR believe that that short warranties are overpriced, but longer ones are underpriced?

Obviously, the total value of repairs over a longer warranty is going to be higher than for a shorter warranty.  That means the median value of covered repairs -- which CR earlier told us is zero -- might move into positive territory.  Is that the difference, the higher median?

In their survey, CR likely found fewer buyers regretting their warranty purchase when they had more time to use it.  Did that change their thinking, the higher satisfaction scores?

Maybe it's an editing issue, and they just said it wrong.  The quote actually appears in a separate section with separate advice for people who *do* decide to buy a warranty.  Maybe they're just saying, "if you *must* buy one, at least buy a long one."  (But it sure doesn't read that way.)

Perhaps they didn't change their mind at all.  Maybe the extra section and the article were written by two different people, with two different opinions.  Or they just cut and pasted their "buy" advice from a previous article, one written before their recent survey data came in.

Or, they're just going with their gut.  Before writing the article, the CR editorial staff thinks, "Newer cars don't break much, so extended warranties are dumb.  But older cars have lots of problems, so it makes sense then."  And then it's all confirmation bias from there.

I really have no idea.

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Sometimes, it seems like Consumer Reports is two different magazines.  You've got the product ratings, which are written by respected sabermetricians.  Then you've got the advice and investigative pieces, which are written by outraged sportswriters who are sure that Jack Morris needs to be in the Hall of Fame, and have the hand-selected numbers to prove it, and logic and reason be damned.

Can I buy just half a subscription?




(Some of my previous Consumer Reports posts are here.)

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3 Comments:

At Saturday, March 22, 2014 4:57:00 PM, Anonymous Mike Downes said...

I just drive my cars for as long as I can so I don't have to make this decision more than once every 15 years.

 
At Saturday, March 29, 2014 7:33:00 PM, Anonymous Anonymous said...

A friend who is an economist explained insurance/extended-warranties this way:

"Insurance is for poor people. If you're not poor, then with few exceptions, you shouldn't buy insurance. But 'poor' is relative. I'm poor relative to some groups of people (e.g. movie stars living in LA) but rich relative to other groups (e.g. 25-year-olds in Mississippi who dropped out of high school). Should I buy Honda's warranty? No way. Why? Because of a combination of 2 factors. First, my expected expenditures on repairs for the Honda are lower than what I'd pay in the warranty; we know that for sure, since Honda won't offer a warranty that's unprofitable to them. Second, (and here's where "poor" becomes relevant), even if I have the worst possible luck, e.g. my engine dies, it's possible for me to pay for it without having a catastrophic outcome, like losing my home or going 4 weeks without eating any food. Should the uneducated 25-year-olds in MS buy the warranty? Perhaps they should. For those folks, they might be able to handle the increase in monthly payments that goes with the warranty, and the warranty will prevent them from suffering a catastrophic outcome. If those people have no savings, then if their engine died and they had no warranty, it could mean not being able to get to work, losing their job, losing their home, etc. So because they're 'poor', the insurance might make sense. But cars are small potatoes. The absolute WORST possible outcome with a car is still well under $20,000 (you can just buy a new car)! Let's consider something bigger, like health insurance. Should I buy health insurance? Yes, absolutely. Why? Because the worst possible outcome in health could involve the need for multiple surgeries and hospital stays running hundreds of thousands of dollars. Those kinds of outcomes could destroy me, financially, so it's worth insuring against them, because I'm 'poor' in this context. But should Justin Bieber pay for health insurance? Probably not. Even the worst possible outcome in health would be just round-off error for him. Bottom line: insurance is for poor people. The more money you have, the more neutral you should be with respect to risk. And any insurance policy anyone will ever sell you is more likely than not to make you lose money (otherwise they wouldn't be offering it to you)."

 
At Thursday, July 17, 2014 3:58:00 PM, Anonymous Anonymous said...

http://www.nationalrepairsolutions.com/#!honda-auto-warranty-online/c250f

 

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